Around tax season, you might hear a couple of terms quite often: tax avoidance and tax evasion. On the surface, these terms seem similar, and some people might use them interchangeably. After all, don't they both result in paying or owing less in taxes?
Let's be clear: Tax avoidance and tax evasion are two very separate things. One is legal and takes advantage of allowable credits and deductions to reduce tax obligations. The other is illegal and uses fraudulent means to skirt tax liabilities, which can result in prison time and/or fines.
The Difference Between Tax Avoidance and Tax Evasion
Tax avoidance involves legal means of lowering the amount owed to the federal government. It often requires strategic planning to determine the methods you can use to reduce your taxable income. Tax avoidance enables you to benefit from credits and deductions built into the Tax Code.
Tax evasion is illegal. Instead of relying on allowable vehicles for decreasing tax obligations, it involves using deceit or fraud to conceal material facts from the IRS. This can result in less taxes being assessed than actually should be.
A Few Examples of Tax Avoidance
When you engage in tax avoidance, you structure transactions by using allowable credits and deductions.
Methods of decreasing tax obligations include, but are not limited to:
- Investing in a retirement account: You can reduce your taxable income by contributing to a 401(k) or a traditional IRA.
- Opening a health savings account: You can deposit pre-taxed dollars into an HSA to lower your tax liabilities.
- Making a charitable contribution: Donations you make to charities can be deducted from your taxes.
- Claiming tax credits: The Tax Code lists various credits you can claim, such as Earned Income Tax or the Child Tax Credit.
A Few Examples of Tax Evasion
According to the IRS, two types of tax evasion exist: evasion of assessment and evasion of payment. Both involve willfully engaging in illegal conduct to attempt to or actually evade tax obligations. To act willfully means to do something intentionally, knowing that it is a violation of the law. Thus, a simple mistake would likely not lead to criminal charges.
Evasion of assessment includes filing a tax return containing materially false information that results in lesser taxes being charged. With evasion of payments, the correct taxes owed is applied, but assets or funds are concealed to make it appear as if the liability cannot be satisfied.
Tax evasion can take many forms, including, but not limited to:
- Not reporting income: An individual might file tax returns that do not include all income earned for the previous year.
- Underreporting income: Similarly, a person might report a substantially lesser income amount than what they actually received.
- Concealing assets: An individual might hide their money or property by keeping accounts in other people's names.
- Taking deductions not entitled to: A person might say they made a charitable contribution when they did not or might claim other deductions they are not eligible for.
- Not reporting cryptocurrency transactions: Crypto transactions resulting in capital gains or losses, such as trading one virtual currency for another or buying goods or services with cryptocurrency, must be reported on taxes.
The Results of Avoiding Taxes
Engaging in legal tax avoidance can lead to a reduced tax obligation. As long as everything is done by the books, you face neither civil nor criminal penalties for decreasing your liability by taking allowable credits and deductions.
The Results of Evading Taxes
On the other hand, tax evasion can result in civil or criminal penalties. In some cases, civil fines can be imposed for actions such as underpaying taxes or fraudulently reporting information.
In other cases, the federal government can prosecute under 26 U.S.C. § 7201 – attempt to evade or defeat tax. The statute provides that a person is guilty of the offense when they willfully do not satisfy their actual tax obligations.
A violation of § 7201 is a felony, punishable by:
- Up to 5 years in prison and/or
- Up to $100,000 in fines for individuals (up to $500,000 in fines for corporations)
What to Do If You Have Been Charged with Tax Evasion
Because the laws are complex, you must reach out to an attorney for help fighting your tax evasion charge. At Keegan, Tindal & Jaeger, our team will review records, transaction logs, and other relevant information to determine how to challenge the accusations against you. We are ready to pursue an optimal result on your behalf.
To schedule a free consultation with a member of our Iowa City team, please call us at (319) 499-5524 or contact us online today.